The following balance sheet and information are given for Carboni Company(CC): C
ID: 2796651 • Letter: T
Question
The following balance sheet and information are given for Carboni Company(CC):
Current Assets
$2,000,000
Current Liabilities
$1,000,000
Short-term Securities
0
Long-term Liabilities
(Bonds)
$5,000,000
Long-term Assets
7,000.000
Equity
$3,000,000
Total
$9,000,000
Total
$9,000,000
Additional information: The CC’s bond has a face value of $1,000 and pays 10 percent semiannual coupon. The bond matures in 12 years and sells at a price of $920 in the bond market. The beta of CC is 1.25, market risk premium is 7.95 percent and risk free rate is 2.50 percent. The CC’s tax rate is 40%.
a. What is Carboni’s WACC?
b. The following information is given for Guatelli Company(GC):
--Bond outstanding: 3,000 bonds, selling at $995 per bond.
--Common stock outstanding: 260,000 shares, selling at $23.40 per share.
--The before-tax cost of debt of the company is 12.31%, beta of Guatelli is 1.40, market risk premium is 7.95%, tax rate 40%, and risk free rate is 2.50%? What is Guatelli’s WACC?
Calculate WACC for both companies. Please describe, in writing, how you calculate WACCs in 6 lines.
***DO NOT JUST GIVE ME AN EXCEL SPREADSHEET FOR THE ANSWER. I NEED TO KNOW HOW YOU DID THE CALCULATIONS AND AN EXPLANATION***
Current Assets
$2,000,000
Current Liabilities
$1,000,000
Short-term Securities
0
Long-term Liabilities
(Bonds)
$5,000,000
Long-term Assets
7,000.000
Equity
$3,000,000
Total
$9,000,000
Total
$9,000,000
Explanation / Answer
Solution :- WACC = Weight of bond * Cost of bond + Weight of equity * Cost of equity.
a). Calculation of WACC of Carboni Company (CC) :-
Cost of equity = Risk free return + Beta * Market risk premium.
= 2.50 % + 1.25 * 7.95 %
= 2.50 % + 9.9375 %
= 12.4375 %
Cost of bond = [ Coupon amount + (Face value of bond - Bond price) / Number of Years to maturity ] / (Face value of bond + Bond price) / 2
= [ 1000 * 10 % * 6 / 12 + (1000 - 920) / 12 * 12 / 6 ] / (1000 + 920) / 2
= [ 50 + 80 / 24 ] / 960
= [ 50 + 3.3333 ] / 960
= 53.3333 / 960
= 0.0556 i.e., 5.56 % (approx).
Annual cost of bond (before-tax) = 5.56 % * 12 / 6 = 11.12 %
Annual cost of bond (after-tax) = 11.12 * (1 - 0.40) = 6.672 %
WACC = 6.672 % * 5000000 / (5000000 + 3000000) + 12.4375 % * 3000000 / (5000000 + 3000000)
= 6.672 % * 5000000 / 8000000 + 12.4375 % * 3000000 / 8000000
= 6.672 % * 0.625 + 12.4375 % * 0.375
= 4.17 % + 4.6641 %
= 8.8341 % (Rounded off to 8.83 %)
Conclusion :- WACC of Carboni Company (CC) = 8.83 % (approx).
b). Calculation of WACC of Guatelli Company (GC) :-
Cost of equity = Risk free return + Beta * Market risk premium.
= 2.50 % + 1.40 * 7.95 %
= 2.50 % + 11.13 %
= 13.63 %
Cost of bond (before-tax) = 12.31 %
Cost of bond (after-tax) = 12.31 % * (1 - 0.40) = 7.386 %
WACC = 7.386 % * (3000 * 995) / (30000 * 995 + 260000 * 23.40) + 13.63 % * (260000 * 23.40) / (30000 * 995 + 260000 * 23.40).
= 7.386 % * 2985000 / (2985000 + 6084000) + 13.63 % * 6084000 / (2985000 + 6084000)
= 7.386 % * 2985000 / 9069000 + 13.63 % * 6084000 / 9069000
= 7.386 % * 0.3291 + 13.63 % * 0.6709
= 2.4307326 % + 9.144367 %
= 11.5750996 % (Rounded off to 11.58 %).
Conclusion :- WACC of Guatelli Company (GC) = 11.58 % (approx).
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